You Really Don’t Own the Shares that Appear in Your Brokerage Account; They Belong to Cede
Most investors when they buy a publicly traded stock believe that they own a part of some company. They think that somewhere there is a stock certificate or some indication of ownership that has their name on it, but this is not the case. When you buy a “stock” you are actually purchasing a security that affords certain entitlement rights related to registered stock which actual owners hold. The registered shares of a private company are directly owned by shareholders. In contrast, the registered shares of nearly all publicly traded equities are owned by Cede & Co., which is the nominee of the Depository Trust Company (DTC). (A nominee is a company whose name is given as having title to a stock, but does not receive the financial benefits of ownership.) Cede is a subsidiary of the Depository Trust Company (DTC) which is a subsidiary of the Depository Trust and Clearing Corporation (DTCC) and the DTCC is a private company owned by elite Wall Street firms and money center banks. If you need background or a refresher on DTC and DTCC, click on this link. Effectively, elite Wall Street firms and money center banks, not institutions and individual investors, own almost all of the registered shares of publicly traded companies in the US.
The DTC is a depository that holds securities of publicly traded stocks in street name (not to be confused with registered stock) for some 600 broker-dealers and banks who have accounts with it. Bear with me, I will explain what street name securities are shortly, but be clear that they are not the registered securities held by Cede & Co. which never leave its vault. It is street name securities that are held in inventories of brokers and are traded from broker to broker in the public markets. These street name securities have contractual rights to the financial benefits of the registered shares owned by Cede and also convey voting rights on corporate governance matters.
Brokers in the aggregate hold inventories of street name securities located in accounts at the DTC. Investor accounts lodged with brokers are also held at the DTC. When we investors buy a stock through a broker it is noted as a digital entry in the DTC’s electronic bookkeeping system so that the broker becomes our nominee. The upshot is that almost all U.S. investors are beneficial rather than registered owners of a stock. This entitles us to receive financial benefits such as dividends and to vote on corporate governance issues. While you may think you are buying registered stock, you are actually buying a financial derivative related to that stock. Effectively, you are buying a financial derivative from brokers of a financial derivative they hold from Cede that is just a digital entry in your DTC account.
Cede is at the center of the current, paperless electronic trading system that enables lightning fast trading of large blocks of stock by institutional investors and computers. Unfortunately, the intention in designing it was to provide liquidity and reduce settlement risk. There is virtually no transparency in the system. Disturbingly, there are loopholes which allow for the counterfeiting of shares by market makers on a massive scale through illegal naked shorting and other measures. At present, there is no way for an outsider or even the securities industry’s regulator, the SEC, to meaningfully detect and track these counterfeit shares. Once created counterfeit shares go on to be treated the same as legitimate street name shares. I discussed how this is done in series 7 of my illegal naked shorting series.
So what is the Harm?
Let me anticipate and answer talking counterpoints that would be made by the DTCC, elite Wall Street firms and hedge funds who flourish in our current clearing and settlement system. I think they would point to prodigious market liquidity and cheap execution of trades. A small investor can put in a buy or sell market order for a 1000 shares of a stock and have it executed in a second and only have to pay $5 or $10. They would then say that investors still retain all of the financial benefits accorded registered shareholders and the ability to vote on corporate affairs. So they would say, isn’t that great? Yes it is great.
Here is what is not so great. We have all been sold the fiction that when we buy a stock, we have become proud owners of a great American corporation. Our investment is funding that Company and America’s growth. This is not an accurate description. As I will show in this report, we are actually involved in commodity trading of street name securities in which the trading of and record keeping is completely controlled by DTCC and the elite Wall Street firms with no transparency for outsiders. Operating in this black hole of important information they use loopholes in the clearing and settlement system administered by DTCC and loopholes in the ineffective SHO regulations to create counterfeit shares at will. They can and do expand the supply of street name securities through creating counterfeit shares to overwhelm demand and drive down the stock price.
You can see this scheme at work almost on an almost daily basis. All too often, when a Company reports approval of an important new product, the stock trades up slightly and then trades down to a lower price than before the announcement to the amazement of investors who are long the stock. The same thing can happen with achievement of a meaningful, clinical, regulatory or financial milestone. Why? Because there are hedge funds who have been shorting the stock and have huge outstanding short positions who stand to suffer huge losses if the stock price increases. In self-defense, they launch a short attack spearheaded by creating counterfeit shares arising from illegal naked shorting. The clear intent is to make good or great news appear to be badly received. Jim Cramer was a long time hedge fund manager before becoming a commentator on CNBC. In this famous interview, he fills us in on how he and other hedge funds routinely manipulated stocks.
God forbid, if a company you are invested in reaches a point that it becomes apparent that it has to raise equity. The hedge fund gang jumps in and start shorting in anticipation of an offering. The hedge funds have had great success in persuading other investors that equity offerings are bad for investors because it dilutes their shares. In most cases, this argument is total nonsense because companies are raising money to enable the completion of projects that will enable them to become successful, i.e. executing an important clinical trial, building infrastructure, etc. Raising equity to enable companies to grow is the cornerstone for our successful economic system. Claiming that equity raises are dilutive and harmful is something that Vladimir Lenin might have said.
In the vast majority of cases, the stock slides sharply when the deal is announced. For small emerging companies, the offering is then priced by Wall Street investment bankers at a 10% discount to the already distressed price and often warrants must be attached in order to attract buyers who all too often the hedge funds who have shorted the stock. Yes, I know this is illegal, but hedge fund A buys stock on an offering to cover for hedge fund B who has been shorting and they switch positions to cover the short and split the profits. This is a routine practice. In the end, this does lead to enormous share dilution, which causes untold harm to investors and emerging companies who are so important to economic growth. The winners are Wall Street and hedge fund employees and real estate brokers in the Hamptons.
The Move to Electronic Trading of Stocks, Some Background
In previous reports, I discussed the system of clearing and settlement of stocks that was used up until the late 1960’s that relied on messengers physically delivering registered shares and cash. As trading exploded, this physical delivery system was overwhelmed and created a major crisis. This necessitated a move toward a paperless, electronic system as a replacement. This new process evolved over the next few decades.
In moving from the old system of physically delivering securities for settlement to a paperless, electronic scheme, a number of difficult issues had to be addressed. Perhaps the most serious was that registered shares are like pieces of property. They physically belong to the owner. Transferring ownership involves a legal process in which the previous owner signs over shares to the purchaser comparable to selling a house. The obvious solution would seem to be to transfer ownership electronically. However, a major stumbling block was that all 50 states had different ways of treating the transfer of registered shares and each would have to pass new legislation to allow this to happen, a process that could be very long and involved. I am not sure that technology at the time existed that could allow electronic transfer of ownership although it could be done easily with today’s technology.
Over time, the architects of the evolving electronic trading system did come up with a solution for dealing with registered stock. In retrospect and unfortunately for many companies (especially emerging growth stocks) and investors in those companies, the fix they settled on has loopholes that allows illegal naked shorting and creation of massive amounts of counterfeit shares. This allows hedge funds to aggressively manipulate stocks. The designers were almost totally focused on providing liquidity and settlement security to the market and gave little thought to almost everything else. Central to their plan was the dematerialization and immobilization of registered shares. Here is what they came up with.
Why Was Cede Created
In 1999, the DTCC formed a subsidiary called Cede and made it the nominee for all registered shares in the US. This meant that Cede’s name appears on registered shares so that today virtually all shares of publicly traded companies in the US are owned by Cede and are immobilized in a central vault. For each registered share, the DTC created a corresponding share that conferred to the owner most of the financial and corporate ownership benefits of registered shares such as receiving dividends , voting in proxies and so on. These are financial derivatives of registered shares that are fungible (commodity-like) which is referred to as dematerializing the registered shares. This meant they could be traded freely without any need for transferring ownership. These securities are now known as street name securities. Securities held in street name are legally distinct from the registered shares held by Cede & Co.
More on Street Name Securities
All of the stock trading in public markets is now done in street name by the DTC and its 600 or so member firms and participants who have accounts at the DTC. Through digital book keeping entries the DTC keeps track of the street name positions of all of these firms. In turn, these firms maintain corresponding digitally based accounts of the stock holdings of their clients.
Brokers have an inventory of street name shares in their accounts which are fungible and can be transferred back and forth electronically allowing for trades to be cleared almost instantaneously. They also maintain and update the security holder records for clients, facilitate or execute selling and buying and provide other services. This means that all DTCC stock trading which is tantamount to all stock trading in the US is done with street name securities which are a financial derivative of registered shares.
Trading in Street Name Allows for Continuous Net Settlement
As customers execute buy and sell orders, brokers interact with the DTCC and other brokers all on an electronic basis and their inventory builds and declines accordingly. This is done through continuous net settlement which I described in detail in Part 7: Illegal Naked Shorting: DTCC Continuous Net Settlement and Stock Borrowing Programs Have Loopholes That Facilitate Illegal Naked Shorting